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M&B 2024 Reading 2: Hyman Minsky

For our schedule and links to other discussions, see the Money and Banking 2024 master post.

The vision of Hyman P. Minsky is an intellectual biography of Hyman Minsky by Perry Mehrling from 1999. Among other things, this reading emphasizes Minsky's financial instability hypothesis and its connection to the "survival constraint": the idea that each economic actor needs to ensure that its cash inflows meet its cash commitments at any given time. We discussed the time patterns of cash flows and cash commitments in Lecture 4. Lining up your cash flows and meeting your survival constraint is the essence of liquidity.

In the Lecture 1, Mehrling says he thinks of this article as the "missing chapters" at the end of his first book, The Money Interest and the Public Interest. In that book, he provides similar intellectual biographies for Allyn Young, Alvin Hansen, and Ed Shaw.

Perry Mehrling says:

There are five sections in this reading, and it is pretty dense reading because I was trying to fit an entire intellectual biography into the length of a journal article. For present purposes, the most important section is the third, titled "Vision", because we are trying to build some intuition about the monetary system. Second in importance is the fourth section "Minsky and the World" which shows how Minsky used his vision to engage with the concrete problems of his own time, an account that may serve as a challenge for present day students of the money view to engage the concrete problems of the present time.

The five sections of the reading are as follows:

1. Life

Minsky had to decide between focusing on research or focusing on his political agenda of using full employment to fight poverty. He ended up choosing research. In his research agenda, he emphasized the role of the central bank as a lender of last resort.

Minsky’s emphasis on the support functions of the central bank as lender of last resort lost out to the dominant emphasis on the control functions of the central bank as manager of the money supply.

Mehrling cites Economic Policy for a Free Society by Henry Simons in reference to the influence that Simons had over Minsky's thinking.

Henry Simons was the source of Minsky’s lifelong interest in finance, as well as the idea that the fundamental flaw of modern capitalism stemmed from its banking and financial structure (Simons, 1948).

2. Character

Production, consumption, and trade, are nothing more than flows of money in and out and between different economic units.

Minsky emphasized the centrality of money. He de-emphasized the role of goods and the real side of the economy. In terms of sources and uses, the sale of a good is just a receipt of money. The purchase of a good is just an expenditure of money.

The most real thing is money, but money is nothing more than a form of debt, which is to say a commitment to pay money at some time in the future. The whole system is therefore fundamentally circular and self-referential. There is nothing underneath, as it were, holding it up.

If the thing you're trying to understand is the monetary system, then money is the most "real" thing. If the system is self-referencial, then a financial crisis is what happens when those self-references come under strain.

3. Vision

Minsky’s worldview concerned not all economies, but only capitalist economies, by which he meant economies that are characterized by private ownership of the means of production. And it concerned not all capitalist economies, but only the ones that have developed a sophisticated system of finance to facilitate the ownership, creation, and refinance of capital assets. In these economies, so he seems to have thought, financial processes take on a life of their own, so that their logic effectively becomes the logic of finance. In Minsky’s own early words: “Capitalism is essentially a financial system, and the peculiar behavioral attributes of a capitalist economy center around the impact of finance upon system behavior” (Minsky, 1967a, p.33, my emphasis). This is the core insight that underlies all of Minsky’s work, and distinguishes his work from that of other economists. According to Minsky, we need to understand finance not because it is an important part of our modern economy, but because it is the very heart and motive force of that economy.

For Minsky, the object of study was "financial capitalism," which was the label he applied to the economic system he lived under in the second half of the twentieth century.

All in all, Minsky’s is a sophisticated vision of modern capitalism. Probably most people who think this way become investment bankers, from which social position it becomes difficult to see clearly the downside of the logic of finance. For an investment banker, problems may arise, but the solution is always more finance or, more precisely, refinance and restructuring of existing commitments in order to make room for new commitments. Not so for Minsky, who never forgot the lessons of Lange and Simons that the logic of finance tends to produce inequality and instability, effects which history shows tend to undermine democratic political forms.

It's not clear to me how generalizable Minsky's insights are beyond our present system of financial capitalism. Where do we draw the boundaries around financial capitalism? What counts as financial capitalism and what doesn't?

4. Minsky and the world

Inflation was difficult for Minsky to understand because of the thoroughgoing nominalism of his thought.

Economists tend to start at the real side and then fit money into their thinking. Minsky seemed to start with money and work backwards. In either case, the price level and inflation lie at the interface between the monetary side and the real side.

Minsky seems to have started from the idea that, because government faces no survival constraint, imbalance between its cash commitments and cash flows shows up not as a tendency to crisis, but as a tendency to depreciation of future cash flows relative to present cash flows. This tendency takes the form of price inflation domestically and currency depreciation internationally. In effect, socialization of a private imbalance between cash commitments and cash flows (in order to avoid crisis) does not change the fact of imbalance, but only the mechanism through which adjustment takes place.

Is it true that the government faces no survival constraint? What about from the central bank? Can the central bank choose not to roll over the government's funding?

Perhaps the central bank and the government jointly face no survival constraint when acting together—at least with respect to the particular money they issue. They can always pay debts denominated in their own money. But the same cash-flow imbalance that would otherwise put pressure on the survival constraint shows up in other prices of money besides par.

5. Minsky and the economists

What made the dollar money? Following Sayers, Minsky eventually came to the view that it is the ability of a unit to force a net cash flow in its favor that gives its liabilities liquidity (Minsky, 1986a). It was the ability of the Fed to make dollars scarce, not so much by reducing the outstanding stock of dollars as by forcing an incoming flow of dollars, that sustained the reserve currency position of the dollar in the dark years of 1979–1982 (Minsky, 1986b). In Minsky’s view, the key channel through which Volcker’s monetarism bolstered the dollar came through the effect of high interest rates on bolstering capital inflows from short-term dollar-denominated foreign debtors.

If you can force cashflows in your direction, then you can always meet your cash commitments. If everyone knows this, then everyone knows that your liabilities are liquid. The question is whether this logic still make sense if your liabilities are the ultimate cash and there's no cash above you in the hierarchy.

To be sure, Minsky always emphasized the ‘endogeneity’ of money, and the origin of money in business finance. Furthermore, as early as 1972b, he emphasized that the central bank does not (and should not try to) control the quantity of money, but only the conditions of refinance.

We have seen that credit expands and contracts as a part of the normal funcitoning of the economy. Controlling the quantity of money means choking off credit at a particular layer of the hierarchy. Which layer that is depends on what you include in your monetary aggregate.

Study Questions

Minsky viewed the money market as the place where the balance between cash commitments and cash flows could be seen most clearly. People who have maturing commitments in excess of their current cash flows face the need to refinance in order to satisfy the “survival constraint”, and that demand for refinance shows up in the short term money rate of interest.

Question 1

What is a cash commitment? What is meant by the “two-edged quality” of a cash commitment? What distinguishes robust from speculative from Ponzi finance?

Here's a relevant quote about the "two-edged quality" of cash commitments.

On the one hand, they structure uncertainty and give definite form to an inherently open-ended system. On the other hand, they commit economic agents to perform actions that may turn out to be impossible, and so pose a threat to future coherence. Continual adjustment is required to maintain a balance between these two aspects, which means to keep the pattern of cash commitments in line with the pattern of expected cash flows. Coherence is thus not a once and for-all thing — it is not equilibrium — but a temporary and a tenuous thing, constantly in flux as time rolls forward.

The cash commitment constrains the person making the commitment. But they usually get something in return for that commitment—perhaps the ability to make a profitable investment. The person receiving the cash commitment receives some predictability about future cash inflows. But they offer something in exchange (cash now).

The degree of fragility or robustness in the economy as a whole ultimately depends on the fragility or robustness of financing arrangements at the level of the constituent economic units. What Minsky called ‘hedge’ finance is an arrangement where cash flows are adequate to meet all foreseeable cash commitments. ‘Speculative’ finance involves cash commitments that can be met only by rolling over debts when they come due. ‘Ponzi’ finance is a particularly precarious form of speculative finance in which it is anticipated that not only the principal, but also the interest on current debts will have to be rolled over.

This classification is not a moral judgment. It's not that a Ponzi-financed firm is doing anything wrong, per se. Everyone is trying to do what they think is profitable. And it could even be that the changing state of the market pushes people's finance away from robustness and toward fragility.

For example, let's say I'm a hedge-financed balance sheet. What if some of the incoming cash commitments fail to come through? This forces me to roll over my debt to others. This has moved me from hedge to speculative financing.

Question 2

Henry Simons “good financial society” is certainly a system of robust finance, since there is no private debt at all. Sketch the balance sheet relationships (business, household, government) that would exist in such a world. In terms of our dichotomy between government bank and bankers bank, is this an extreme version of the government bank system?

Simons is imagining something like a pure-money system, which we looked at in Lecture 4.

For Simons, the problem was instability and the solution was the suppression of private debt finance in favor of a system of private equity finance and public debt (100% money).

Nobody can fail to meet cash commitments if they make no cash commitments in the first place.

Here are the balance sheets I drew up.

r/moneyview - M&B 2024 Reading 2: Hyman Minsky

Part A shows households investing in businesses by buying ownership shares. This entitles them to a share of the businesses' net assets (assets minus liabilities). But in a world without private debt, that's the same thing as total assets.

Notice that there are no promises of future cashflows at any particular time or in any particular amount. There's just a promise that you'll get a share of what's left if it's ever time to divide up the asset pie.

There is a sense in which equity is a kind of debt. Equity, as a balancing item, defines a residual. It's an IOU for whatever happens to be left over. Importantly, it's a flexible kind of debt. You can't fail to meet your commitment because you only commit to what you can do. There's no survival constraint.

Part B shows households buying goods from businesses. It's a pure asset swap: an exchange of goods for money. There is no expansion or contraction of balance sheets.

Similarly, Part C shows businesses buying labor from households. Same story. It's just an asset swap.

Parts D and E show the government expanding and contracting the money supply through spending and taxing. This can have various effects depending on where and how the money is added or removed. Notice that I'm just showing unidirectional payments. There may sometimes be another side of the transaction. The government can buy or sell something.

As to the question of government bank versus bankers bank, we usually discuss that in the context of a central bank. In the balance sheets I drew, there is no central bank. But we can imagine that the government issuing money directly is equivalent to the central bank monetizing government debt. So, in this sense, it's like an extreme version of the government bank scenario.

There can't be bankers bank because there are no bankers and no private banks. You can't have private banks if you don't have private debt. I'm not sure if Simons was imagining a world without banks, per se. Maybe he didn't consider bank deposits a form of private debt if they were 100% backed by reserves. But that's how I've drawn it up in my balance sheets.

Question 3

The Financial Instability Hypothesis suggests that there is a tendency for robust finance to give way to speculative and then Ponzi finance. Why? Why do people make cash commitments in the first place? Why do cash commitments that finance a profitable investment wind up relaxing future survival constraints?

Private credit expands over time.

As credit expands, someone will have to take on the liquidity risk. It's impossible for whoever's doing that "banking" to be robustly financed because they hold long-term assets against short-term liabilities. In other words, their pattern of cash commitments is, on average, dated sooner than their pattern of cash inflows. They must therefore roll over those commitments.

Robust finance gives way to fragile finance as ‘margins of safety’ are eroded and commitments leave less and less room for possible shortfalls of cash flow.

The banking system is paid to take on more and more liquidity risk. The margins of safety are eroded because businesses want to borrow more and more. And it's often the case that the central bank makes this possible/worthwhile by ensuring that credit is cheap.

Concretely, the cash commitments of each unit depend on the cash commitments of every other unit. The whole web of interlocking commitments is like a bridge we spin collectively out into the unknown future toward shores not yet visible. Mere ideas about the future become realities as they become embedded in financial relations, but inevitably over time the reality embodied in the pattern of cash commitments diverges from the reality embodied in the pattern of cash flows.

The system can be more or less stable, depending on the extent to which cash commitments depend on other cash commitments. On the way up, during boom times, the financial system gradually becomes more "interlocked" and susceptible to collapse. If a promised cash flow fails to materialize or is delayed, that can push a formerly robust unit into speculative finance or a formerly speculative unit into Ponzi finance.

During a credit contraction on the way down, even previously robust units can instantaneously turn into Ponzi units as they become unable to roll over their funding. This can quickly turn illiquid units insolvent as they're forced to sell their assets at fire-sale prices. This is true even if those assets are fundamentally sound—they would have reliably generated all the promised cash flows.

Inevitably our ideas about the future are wrong, even when we all agree, indeed especially when we all agree. Just so, widespread belief in the 1960s that economists had learned to tame economic fluctuation led units to the ‘euphoric’ view that future cash commitments were relatively unproblematic, and once this view became embedded in the structure of debt contracts, it became a constraint on future action.

Why do people make cash commitments in the first place?

People make cash commitments for the future if they get something worthwhile in return, such as a cash inflow today to finance a profitable new investment. Or we may need to roll over our existing cash commitments. I can promise to pay more in the future to get out of having to pay cash today.

Why do cash commitments that finance a profitable investment wind up relaxing future survival constraints?

A profitable investment generates cash inflows that exceed the cash outflows needed to fund the investment. You end up with more cash than had you not invested.

Question 4

Minsky views the lender of last resort function as central to monetary policy. How does lender of last resort work (balance sheets please)? Why does it work to forestall an incipient crisis?

Lender of last resort allows borrowers to roll over their funding (refinance their positions) when the survival constraint would otherwise force them to default.

r/moneyview - M&B 2024 Reading 2: Hyman Minsky

In this set of balance sheets, the lender-of-last-resort operation acts to restructure the bank liabilities in a way that pushes off their cash commitments into the future.

I show two different quadruple-entry transactions here. The first is a mutual obligation between the banking system and the central bank. This expands the banking system's balance sheet. Then the balance sheet contracts back down. The withdrawal of deposits drains the reserves—asset disintermediation. Without sufficient reserves, the banking system would have defaulted.

From the perspective of the banking system, they have refinanced their position. But the lenders have changed. Instead of their lending being funded by deposits, that lending is now funded by loans from the central bank.

By definition, speculative financing arrangements require periodic refinance, at which point both borrowers and lenders get to take a second look at the balance between the borrower’s future cash flows and future cash commitments in light of the changed financial conditions in the economy as a whole. Any evolution toward fragile finance is therefore bound to show up as increasing difficulty rolling over debts as they mature, difficulty that may manifest itself in various ways depending on the institutional framework, but which ultimately shows up as increased demand for bank lending because banks are the lenders of last resort to non-financial economic units. Significantly, banks are themselves speculative financing units that face their own problems of refinance both because of their extreme leverage and because of the short-term character of their liabilities. Thus, the ability of banks to help other units refinance depends on their ability to refinance their own positions.

The central bank can also supply reserves by buying assets. The below set of balance sheets shows three different ways the central bank can act as lender of last resort.

r/moneyview - M&B 2024 Reading 2: Hyman Minsky

Scenario A shows the central bank lending to a bank who comes to the discount window for a loan. This expands the bank's balance sheet on both sides. A reserve drain can shrink it back down smoothly. Minsky (in keeping with Bagehot) wants the discount window to be a facility that backstops the whole market rather than being associated with troubled banks.

Scenario B shows the central bank buying TBills from the banking system. In this case, the asset sides of the banks' balance sheets improve, but the balance sheets do not expand. A reserve drain will leave the banking system with a smaller balance sheet.

Scenario C shows the central bank lending through the repo market. This can be done at the initiative of the central bank, as in the case of open-market operations. Or it can be done at the initiative of the borrowing bank, as in the case of a standing repo facility. The standing repo facility is analogous to the discount window, but it is often available to different counterparties.

Why does it work to forestall an incipient crisis?

By preventing defaults at the level of individual balance sheets, lender of last resort prevents a cascading chain of defaults transmitting through multiple balance sheets.

What worried Minsky was the prospect that, left to its own devices, the financial system would operate to amplify rather than to absorb the naturally cyclical process of growth, as each commitment provides the support for others on the way up, and as default on some commitments undermines other commitments on the way down. Minsky thus saw a natural role for government, as lender-of-last-resort to ensure a lower bound on downward fluctuation in times of crisis, and as regulator during more peaceful times to identify and correct imbalances before they pose a threat to the system.

Question 5

Minsky viewed the US in the 1970s as an “ailing bank”. Persistent negative cash flows at the international level led to persistent depreciation of the dollar and rising domestic inflation. What parts of this analysis carry over to the present day, and what parts do not?

In 2024, we're coming down from a bout of inflation. But the US, in aggregate, is not as much of a bank as it was back in Minsky's time. The dollar system is global. It transcends the United States. And the United States is less the financial sector of the dollar system. There are parts of the dollar system that, in aggregate, act like a bank to the rest of the world, expanding their balance sheets on both sides by holding longer-term assets and issuing shorter-term liabilities to fund them.

In 2015, Mehrling published a shorter biography of Minsky on his blog that further emphasizes the role of Joseph Schumpeter:

For more on Minsky, I recommend the book Minsky by Dan Neilson (u/soon-parted).

Please post responses to the study questions, or any other questions and comments below. We will have a one-hour live discussion of this lecture on Wednesday May 29th at 2:00pm EDT.

Thinking Snoo

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